'Big Brands' offer protection in a world of disruption

Six challenges, however, are testing the effectiveness of their emotional pitches.

SEP 2018
Michael Collins
Investment Specialist

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Australian entrepreneur Dick Smith teared up when he heralded the closure of his 19-year-old locally sourced all-profits-to-charity Dick Smith Foods because the German discount chain Aldi, which only entered Australia in 2001, has “destroyed us”.[1]

Smith said, when announcing the closure in July, that he had written to Coles, Metcash and Woolworths to warn them that Aldi’s “ruthlessly astute” business model would make them “uncompetitive” unless they slashed products lines and got “rid of about 75% of their staff”.[2] Smith rued that research showed Aldi, which was founded in 1913 in Essen, was the most trusted brand in Australia,[3] a success built on “modern extreme capitalism”.[4]

It sure is capitalism, anyway. ‘Creative destruction’, as it was described by Austrian economist Joseph Schumpeter in 1942, is a Marxist term for the endless competition that drives capitalism.[5] An updated perspective, with consumer goods at least, would be that it’s a perpetual battle between ‘brands’, a concept developed from the 1950s. The prevailing victors are ‘Big Brands’.

The first is the focus on health, especially the fight against obesity that targets sugar. A second is that escalating trade disputes are ensnaring Big Brands as they have a prominence that makes them targets for retaliation. Another is that social media has given rise to insurgent advertising and is a vehicle for anybody to publicise brand-damaging incidents the world over. The fourth is the internet allows easy price comparison, which reduces the ability to charge premium prices. Another challenge is that franchising is a riskier business model in the age of social media and retail disruption. The last threat is that market dominance has become a political issue and policymakers could restrict Big Brands. All up, Big Brands are vulnerable in a world where only being the biggest of Big Brands affords enough protection.

Plenty of Big Brands have glided through worse and the popularity of many products almost seems external. As Apple’s Steve Jobs once told Bernard Arnault, the chairman and CEO of French luxury-goods company LVMH, “I don’t know if in 50 years time my iPhone will still be a success but … everyone will still drink Dom Pérignon.”[6] Many people will always eat junk food too, and Big Brands have had notice to prepare for when sugar is the ‘new tobacco’. Most Big Brands will duck the trade wars. Only the gigantic are vulnerable to competition regulation. But today’s challenges are formidable and ensnare enough Big Brands to raise concerns that big consumer companies face years of sluggish growth.

Emotional appeal

Robert McNamara was US defence secretary from 1961 to 1968. In David Halberstam’s book on the Vietnam War, The best and the brightest, McNamara was the intellectual who formed the war’s metric-heavy attrition strategy encapsulated in body counts and kill ratios. Prior to that, McNamara became the first non-family president at Ford Motor where he spent 15 years applying his rationality to selling cars.

The safety-conscious technician, however, struggled to rein in General Motors with his pursuit of graceless but efficient cars. “He thought the customer should be rational,” Halberstam writes. McNamara’s critics at Ford tried to convince him that cars were bought “on impulse”; that buyers “will opt for comfort and status every time”.[7]

McNamara, in effect, failed to grasp the insight the consumer giants had gained at the time; that marketing emotion was how to sell quality goods when competing against other worthy goods. Previously, quality goods had relied on being of better quality for market share. But improvements in production led to a world of goods of similar quality.

To create ‘category leaders’, titans such as Procter & Gamble and Unilever studied their products and customers to form ‘branded propositions’, or marketing strategies, that tugged on emotions to magnify product advantages or nullify deficiencies. Philip Morris’s rugged Marlboro Man, for instance, was designed to overcome the view that filtered cigarettes were effeminate.

Appeals to self esteem, aspiration, winning and optimism succeeded in two ways, as long as product quality held; they helped build market share and allowed companies to charge more. Retail chains noticed this success. So they developed brands, which spawned ‘own’ labelled goods.[8]

Marketing has sharpened to include logos, tag lines, celebrity endorsement, even company ‘values’. The result? The best Big Brands have emotional appeals that make them hard to disrupt. That such companies have huge marketing budgets, economies of scale, political influence, the balance sheets to buy competitors and control their distribution make them even harder to usurp – especially when brands hold the top two spots in categories, an advantage that is even more telling on the internet because people tend to only look at the top results of online searches due to limited screen space. Even with these advantages, however, Big Brands faces challenges to escape recession-level growth rates.

Healthy trade

Tonga’s Prime Minister Akilisi Pōhiva proposed an unusual challenge to other regional leaders before the Pacific Forum in August; that they stage a weight-loss competition as an example to their overweight citizens because nothing else has reduced obesity among Islanders. “(It) has everything to do with our eating habits,” Pōhiva said, referring to how Islanders prefer processed foods and fatty meats over traditional diets.[9]

While Pacific leaders are yet to publicly accept Pōhiva’s challenge, they are part of a worldwide quest to promote healthier eating to fight obesity and linked diseases. It’s a campaign that targets sugar – fat to a lesser extent – and one that undermines the sales growth of sugary food and beverage Big Brands.

The World Health Organisation urges countries to match Mexico’s decision in 2014 to introduce a tax on sugary drinks, which battered sales of sweetened drinks by 12% the following year (though they bounced back and such taxes have had limited effect in other countries).[10] Now more than 25 countries have such taxes and the Australian Medical Association urges Australia to do likewise “as a matter of priority”.[11] Other steps against sugar include education campaigns, advertising restrictions, labelling to show sugar enrichment, demands that catered-to populations (patients, the military and schoolkids) receive more nutritional food, even legal action.[12]

Big Brands are responding by reducing sugar content, launching healthier products, expanding into non-sugary businesses and substituting sugar with artificial sweeteners, though this switch is backfiring because sweeteners are proving to be health risks.[13] The campaign to reduce the obesity that has been a health issue since the 1970s will threaten processed-food companies for the foreseeable future.

A more recent challenge to Big Brands is the danger posed by trade and other international brawls. Many are multinationals that export, have global supply networks and make prominent targets for retaliation. During a diplomatic dispute with the US in August, for example, Turkey imposed tariffs of between 50% and 140% on US rice, alcoholic spirits, tobacco and cosmetics that enmeshed many Big Brands,[14] while President Recep Tayyip Erdoğan urged a boycott of iPhones.[15]

While Turkish tariffs might not ruffle Big Brands too much, an intensification in the China-US trade spat would. Daimler in May became the first Big Brand to issue a profit warning due to China-US trade barriers.[16] More such warnings are likely, especially if Beijing resorts to consumer boycotts on companies such as Apple and Starbucks for which China is a key market. In recent years, Beijing has enacted boycotts on French, Japanese and Korean goods for political reasons.

The EU did as much in May when, as a retaliatory step, it targeted US products such as peanut butter, motorcycles, bourbon whisky and juices – all, by default, Big Brands – that are made in states that voted for US President Donald Trump.[17] The danger for Big Brands was reinforced when Trump in June tweeted against Harley-Davidson for waving “the white flag” when the company decided to move production from the US to preserve EU sales.[18] In August, Trump encouraged US consumers to boycott the US motorcycle icon.[19]

Franchise and internet threats

Isaac Singer started the first modern franchise when he expanded his sewing business across the US in the 1850s by adopting a practice that traces to the Middle Ages when landlords allowed peasants to operate markets under rules that became part of European common law.[20]

The modern twist with franchising is that the squeezing of Big Brands has amplified the central flaw in the business model; that franchisers can’t control how franchisees behave. This risk is brand damage if they misbehave.

In Australia, the pressure on retail has led to underpayment scandals at franchisees tied to 7-Eleven,[21] Caltex Australia[22] and Domino’s Pizza Enterprises,[23] among others, such that Caltex (which is now abandoning franchising) [24] and 7-Eleven were sanctioned by the Fair Work Ombudsman. Such scandals prompted the Senate to launch a parliamentary inquiry into the practice that employs more than 500,000 Australians.[25] The findings due in September are likely to be relevant overseas.

The rise of the internet presents headaches for Big Brands. One challenge is the ease of price comparison either via apps such as ShopSavvy and BuyVia or by checking on Amazon.com. This development limits the ability of Big Brands to charge premium prices.

Social media has created two vulnerabilities for Big Brands. The first is anyone with a smartphone can publicise a brand-damaging act worldwide. Starbucks, for instance, was ‘shamed’ in April when a customer filmed the arrest of two black men for refusing to “make a purchase or leave” at an outlet in Philadelphia and loaded the video onto Twitter where it went viral. Starbucks apologised and compensated the men but its decision to educate staff about ‘unconscious racial bias’ was criticised – and lauded – on social (and traditional) media.[26]

The other vulnerability is that social media allows startups to conduct low-budget insurgent advertising. This means Big Brands have lost some of the advantage that a large marketing budget once offered, even if social media opens a new valuable marketing channel for them. The Dollar Shave Club’s “Our blades are f***ing great” social-media campaign went so viral in the US that Unilever in 2015 paid US$1 billion for the four-year-old startup to expand its presence in the men’s shaving market (and further erode the market share of Gillette, which is owned by Procter & Gamble).[27]

The challenge of success

July 4 is Independence Day in the US. People barbecue sausages and hot dogs, slap mayonnaise, tomato sauce and spices on food, munch on potato and tortilla chips and guzzle beer. About 11 Big Brands control most of what’s consumed.

Three companies, for instance, sell about 60% of hot dogs and sausages eaten. Two companies hog 66% of beer sales. One company sells 59% of potato chips and 71% of tortilla chips. Two companies have 80% of the mayonnaise market. One of them and one other enjoy 75% market share of ketchup. One company has grasped 48% of the spices market. One company makes 59% of barbecue grills. Another produces 80% of the charcoal burnt. The figures were compiled by the Open Market Institute, a body that lobbies against excessive market power.[28]

It’s a political cause gaining popularity and targets companies in many industries (including Big Tech). Among the consumer Big Brands, the focus is Amazon, more a Monster Brand as the company controls more than 50% of US online sales and about 5% of retail sales. An added concern is that Amazon promotes ‘own’ labelled goods that compete against products it hosts, and competes across so many industries outside retail.[29] The issue is not necessarily Amazon’s influence within an industry but across the economy.

Economists regard monopolies and oligopolies as harmful because they kill competitors, stifle innovation and sabotage producers in adjacent industries (think Amazon and authors). They say monopolists hobble economic growth because they reduce wages and hence consumption and they don’t invest enough as their pricing power and abnormal profits reduce their need to improve. Another charge is that these bloated profits boost inequality.[30] Central bankers even scheduled a discussion on the economic costs of reduced competition and the consequences for monetary policy at their annual gathering in August at Jackson Hole.[31]

Big brands will be in regulatory danger if the shift in anti-trust moves away from just looking at consumer prices and focuses on the wider economic and social costs of excessive corporate power. The pressure for regulators to act against Big Brands will intensify as more companies in more industries vanish like Dick Smith Foods.

By Michael Collins, Investment Specialist

[1] The Australian. ‘Dick Smith Foods to close as Aldi kills competitiveness.’ 26 July 2018. theaustralian.com.au/business/dick-smith-foods-to-close-as-aldi-kills-competitiveness/news-story/61af54988420b98d9039b308e61cb586?utm_source=The%20Australian&utm_medium=email&utm_campaign=editorial&utm_content=TodaySHeadlines

[7] David Halberstam. ‘The best and the brightest.’ Ballantine Books. 1969. Pages 235-236.

[8] See, Marc de Swaan Arons, co-founder and chairman of consultancy EffectiveBrands (now Millward Brown Vermeer) in The Atlantic. ‘How brands were born. A brief history of modern marketing.’ 3 October 2011. theatlantic.com/business/archive/2011/10/how-brands-were-born-a-brief-history-of-modern-marketing/246012/#slide8

[12] In March, for example, Australia’s Federal Court ruled that Heinz be fined for claiming a sugary snack for toddlers was healthy, an action initiated by the Australian Competition and Consumer Commission. The Sydney Morning Herald. ‘Heinz misled consumers over health benefits of children’s snack.’

[17] Release issued by World Trade Organisation at request of the EU. ‘Immediate notification under article 12.5 of the agreement on safeguards to the council for trade in goods of proposed suspension of concessions and other obligations referred to in paragraph 2 of article 8 of the agreement of standards.’ 18 May 2018. trade.ec.europa.eu/doclib/docs/2018/may/tradoc_156909.pdf

[25] Parliament of Australia. ‘The operation and effectiveness of the franchising code of conduct.’ aph.gov.au/Parliamentary_Business/Committees/Joint/Corporations_and_Financial_Services/Franchising

[26] Associated Press. ‘Black men arrested at Starbucks settle with the company.’ 2 May 2018. apnews.com/774de094bff34421af4cb250a20475dc

[27] To learn more, see: The New York Times ‘$1 billion for Dollar Shave Club: Why every company should worry.’ 26 July 2016. nytimes.com/2016/07/27/business/dealbook/1-billion-for-dollar-shave-club-why-every-company-should-worry.html

[29] Amazon, which started selling books online in 1995, now publishes books, owns bookstores, runs an express post service, creates content, distributes videos, operates a cloud business, sells groceries, has entered the market for prescription drugs and lends to small businesses. Many expect it to enter the payments and other industries.

[30] See the Washington Center for Equitable Growth. Working paper 2018-02: Gauti Eggertsson, Jacob Robbins and Ella Getz Wold from Brown University in the US. ‘Kaldor and Piketty’s facts: The rise of monopoly power in the United States.’ 12 February 2018. equitablegrowth.org/working-papers/kaldor-piketty-monopoly-power/

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